Market Update for the Period Ending October 31, 2012Market Condition: Bull Normal

by Van K. Tharp, Ph.D.

I always say that people do not trade the markets; they trade their beliefs about the markets. Consequently, I'd like to point out that these updates reflect my beliefs. I find the market update information useful for my trading, so I do the work each month and am happy to share that information with my readers.

If, however, your beliefs are not similar to mine, then this information may not be useful to you. If you are inclined to perform some sort of intellectual exercise to prove one of my beliefs wrong, simply remember that everyone can usually find lots of evidence to support their beliefs and refute others. Know that I acknowledge that these are my beliefs and that your beliefs may be different.

These updates are in the first issue of Tharp's Thoughts each month. This allows us to get the closing month's data. These updates cover 1) the market type (first mentioned in the April 30, 2008 edition of Tharp's Thoughts and readable on our web site), 2) the five-week status on each of the major U.S. stock market indices, 3) our four star inflation-deflation model plus John Williams' statistics, and 4) the movement of the dollar. I now report on the strongest and weakest areas of the overall market in a separate SQN® Report. I may come out with that report twice a month if there are significant market charges.—Van K. Tharp

Part I: Commentary—The Big Picture

On November 1, the headlines in the newspaper USA Today proclaimed that the election winner would get a mess of a whole series of fiscal cliffs about to happen. About 55 days after the election a convergence of tax increases and spending cuts will throw the economy into a recession (even though we’ve unofficially been in one since 2000). Almost every tax cut enacted since 2001 is set to expire at the end of the year. The tax bite for the average American household is expected to be $3,500. Even Obama’s 2009 economic stimulus tax cuts will expire. In addition, $1.2 trillion in spending cuts will also start. Because we have been expecting a close election, the winner won’t have a mandate from which to act. It will be a mess.

In addition, we’re already in a recession (based upon real CPI numbers and not the fake government statistics) and you can begin to see the true size of the mess ahead. We do have QE3, but aside from it having difficulty keeping sustained trends in a mild bull market, there is nothing too optimistic ahead. But then again, crisis always inspires opportunity somewhere.

According to the U.S. National Debt clock, (www.usdebtclock.org), our National Debt stands at $16.22 trillion. Federal tax revenue for the year is currently at $2.426 trillion while spending is at $3.55 trillion – over a 50% deficit over spending. The U.S. trade deficit for the year stands at $776.58 billion. The total debt in the US per family is $702,824 while the average family has less than $5,000 in savings. In addition, U.S. unfunded liabilities now total $121.265 trillion - or over one million per taxpayer. Do you see any way to overcome these problems that doesn't have consequences? Do you understand what I mean by terrible fundamentals?

The debt clock also shows this month’s population for the US at 314 million. We have a work force of 143 million supporting 68.056 million retirees or social security recipients and 47.1 million food stamp recipients are included in that population. So far this year, there have been 1.3 million bankruptcies and 789,078 foreclosures. Some of those numbers are down from last month which doesn’t make sense, but I’m just reporting what the web site says. The site recently started tracking data second by second and I’ll update you monthly with its figures so you can see the changes over time.

Some of the numbers may go down or up and not make sense, but, like I said, I’m just reporting the monthly figures as I see them on the debt clock.

Beginning this month for six months, it’s now favorable to see a seasonal trend of pension money flowing into the stock market. So we’ll have both that and QE 3 supporting the market although in my opinion, QE3 is just the Fed supporting its owners -- the big banks. It’s also been an election year, with whatever effect that has on the economy, but that’s about to end.

Part II: The Current Stock Market Type Is Bull Normal

Each month, I look at the market SQN® score for the daily percent changes in the S&P 500 Index over 200, 100, 50 and 25 days. For our purposes, the S&P 500 Index defines the market.

The 100 and 200-day SQNs are both bull, the 50 day is now showing bear, and the 25 day shows strong bear. So obviously the short term trend is now down.

Here’s a weekly candlestick chart of the S&P 500, we’ll been in an uptrend since mid-May which is why the short term market type measures are bullish.

The next graph shows that the volatility has crept up to normal over the past two months. And since bear markets are usually very volatile or at least volatile, we have a little room to go before that happens. The VXX is still very weak even though it just went through a reverse split.

The next chart shows the activity of the three major U.S. indices at the closing Friday of each week for the last month. The market is not so strong anymore, partially due to the down movement in AAPL which certainly affects the NASDAQ 100. Nevertheless, both the S&P 500 and the NASDAQ 100 are up over 10% this year.

Lastly, Jason Goepfert’s Daily Sentiment Report for November 1st suggests that smart money is 46% confident in a rally and dumb money is 50% confident. That’s a pretty neutral picture.

Part III: Our Four Star Inflation-Deflation Model

In the simplest terms, inflation means that stuff gets more expensive, and deflation means that stuff gets cheaper. There’s a correlation between the inflation rate and market levels, so the inflation rate can help traders understand big-picture processes. Right now, we seem to have a deflationary trend and in a deflationary market, cash is king.

Here is my four star inflation-deflation model for the last couple of years and the last few months.

Date

CRB/CCI

XLB

Gold

XLF

Total Score

Dec 05

347.89

30.28

513.00

31.67

Dec 06

394.89

34.84

635.50

36.74

Dec 07

476.08

41.70

833.30

28.90

Dec 08

352.06

22.74

865.00

12.52

Dec 09

484.42

32.99

1,104.00

14.10

Dec 10

629.53

38.47

1,410.25

16.00

Dec 11

564.37

33.50

1,574.59

13.00

Mar 12

572.94

36.97

1,662.57

15.80

+1.0

Apr 12

558.55

36.67

1,651.25

15.43

-2.5

May 12

508.76

33.82

1,606.00

14.00

-3.5

Jun 12

539.66

35.29

1,598.50

14.64

-2.0

Jul 12

560.88

34.84

1,622.00

14.66

-1.0

Aug 12

576.91

35.65

1,648.50

15.16

-2.5

Sep 12

585.43

36.80

1,776.00

15.59

+2.0

Oct 12

563.88

36.03

1,719.00

15.90

0

Looking back over the most recent two-month and six-month periods provides the current month's score, given in the table below.

Month

CRB
2 Mo

CRB
6 Mo

XLB
2 Mo

XLB
6 Mo

Gold
2 Mo

Gold
6 Mo

XLF
2 Mo

XLF
6 Mo

Total Score

Current Level

Lower

Higher

Higher

Lower

Higher

Higher

Higher

HIgher

October 2012

+1/2

-1/2

+1

-1

0

Again we moved away from an inflationary scenario. Only two months of the ten so far in 2012 have shown an inflationary tendency.

Shadowstats.com still shows that the real inflation rate is about 5%. And based upon those statistics, the GDP has shown negative growth since 2000 (meaning recession) in all but one quarter of 2003.

Part IV: Tracking the Dollar

Look what has happened to the US dollar recently. We had a huge decline from 84 in July to below 79 in September and since then, we have had a slight up movement that has fluctuated around 80.

General Comments

The market is bullish long term and short term it’s bearish. We’re getting into the time of the year when pension money flows into the market. And at the same time, regardless of who wins the election, the US faces a huge crisis at the end of the year and there’s little bi-partisan support to fix it.

These monthly market updates are not intended for predictive purposes; rather, they’re intended to help traders decide which of their trading systems should work best in the current market conditions. In bear markets—which are almost always volatile by nature—shorter-term strategies, and those that allow going short, tend to work better than long-only or intermediate/longer-term systems.

Which of your trading systems fit this current market type? Of course, this question implies that you have multiple trading systems and that you know how they perform under various market conditions. If you haven't heard of this concept or the other concepts mentioned above, read my book Super Trader, which covers these areas and more, so that you can make money in any kind of market conditions.

Crisis always implies opportunity. Those with good trading skills can make money in this market—a lot of money. There were lots of good opportunities in 2011 and, so far, many more in 2012. Did you make money? If not, then do you understand why not? The refinement of good trading skills doesn't just happen by opening an account and adding money. You probably spent years learning how to perform your current job at a high skill level. Do you expect to perform at the same high level in your trading without similar preparation? Financial market trading is an arena filled with world-class competition. Additionally and most importantly, trading requires massive self-work to produce consistent, large profits under multiple market conditions. Prepare yourself to succeed with a deep desire, strong commitment and the right training.

About the Author: Trading coach and author Van K. Tharp, Ph.D. is widely recognized for his best-selling books and outstanding Peak Performance Home Study Program—a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.vantharp.com. His new book, Trading Beyond The Matrix, is expected for publication March 2013.

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Trading Tip

October 2012 SQN® Report

by Van K. Tharp

There are numerous ETFs that now track everything from countries, commodities, currencies and stock market indices to individual market sectors. ETFs provide a wonderfully easy way to discover what’s happening in the world markets. Consequently, I now use the System Quality Number® (SQN®) score for 100 days to measure the relative performance of numerous markets in a world model.

The SQN 100 score uses the daily percent change for a 100-day period. Typically, an SQN score over 1.45 is strongly bullish; a score below -0.7 is very weak. We use the following color codes to help communicate the strength or weakness of the ETFs.

The world market model spreadsheet report below contains most currently available ETFs, including inverse funds, but excluding leveraged funds. In short, it covers the geographic world, the major asset classes, the equity market segments, the industrial sectors and the major currencies.

World Market Summary

The SQN world market summary has more green in it than I’ve seen in a while. And there are no red areas except for the US dollar and VXX. Most of the US stock market is light green except for the growth sector. Most of Europe is green and much of Asia is green. The only brown is China which is just barely negative.

In addition, almost all the US and global sectors are yellow or green with the lone exception of the semi-conductor sector and VXX (which I’d expect to be low in a bull scenario).

Even most currencies are good except the Japanese Yen and the US dollar.

The next chart shows real estate, debt instruments, commodities, and the top and bottom ETFs for the past 100 days.

People are moving out of bonds because all of the longer term bonds are now yellow to brown. And only the short term bonds are light green. However, corporate bonds and junk bonds are among the strongest sectors.

Most gold and silver ETFs and natural gas ETFs have moved from red to light green in the last three months. Timber is now dark green. Coal, oil, and steel are still weak among the commodities, but they have moved into yellow territory. World real estate (without the US) is quite strong.

This is the first time in quite a while I’ve seen ETFs ranked with an SQN score over 3, with one actually over 4.0. Do you have any idea what it takes to push an SQN 100 based upon daily percent changes to 4.0 or above? It’s pretty amazing.

Anyway, here are our amazing top five:

1) JP Morgan emerging markets bonds at 4.01

2) US Preferred Stock Index at 3.83

3) Powershares Financial Preferred 3.40

4) Barclays Intermediate Credit bd 3.30

I’m not sure what it means that these four ETFs are so strong, I’m just reporting it.

The bottom ETFs seem to be short funds and the VXX.

What's Going On?

Somehow with the short term picture being bearish and the longer term picture being bullish, I’m rather mixed on the market. My personal position is about 50% cash because I’m not that particularly excited about anything.

As I’ve said in previous months, the big picture is not that good. Fundamentally, the U.S. is in the worst shape it’s been in a long, long time. Our debt looks asymptotic and the dollar could soon be dismissed as the world’s reserve currency. Lastly, China isn’t doing that well either, and as a result, it is no longer buying up the world’s supply of commodities. This is almost exactly what I said last month and little has changed.

Crises always offer opportunities, but to capture those opportunities you MUST know what you are doing. If you want to trade these markets, you need to approach them as a trader, not a long-term investor. We’d like to help you learn how to trade professionally. Trying to navigate these markets without an education is hazardous to your wealth.

All the beliefs given in this update are my own. Though I find them useful, you may not. You can only trade your beliefs about the markets.

Until next month, this is Van Tharp.

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